Annual Reports

 
Quarterly Reports

  • 10-Q (Nov 1, 2013)
  • 10-Q (Aug 2, 2013)
  • 10-Q (May 3, 2013)
  • 10-Q (Nov 6, 2012)
  • 10-Q (Aug 6, 2012)
  • 10-Q (May 8, 2012)

 
8-K

 
Other

CAPITALSOURCE 10-Q 2011
e10vq
Table of Contents

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2011
 
Commission File No. 1-31753
 
 
     
Delaware   35-2206895
(State of Incorporation)   (I.R.S. Employer Identification No.)
 
5404 Wisconsin Avenue, 2nd Floor
Chevy Chase, MD 20815
(Address of Principal Executive Offices, Including Zip Code)
 
(301) 841-2700
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
As of July 28, 2011, the number of shares of the registrant’s Common Stock, par value $0.01 per share, outstanding was 322,795,880.
 


 

 
 
             
        Page
 
  Financial Statements        
    Consolidated Balance Sheets as of June 30, 2011 (unaudited) and December 31, 2010     3  
    Consolidated Statements of Operations (unaudited) for the three and six months ended June 30, 2011 and 2010     4  
    Consolidated Statement of Shareholders’ Equity (unaudited) for the six months ended June 30, 2011     5  
    Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2011 and 2010     6  
    Notes to the Unaudited Consolidated Financial Statements     7  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     54  
  Quantitative and Qualitative Disclosures about Market Risk     90  
  Controls and Procedures     90  
 
PART II. OTHER INFORMATION
  Unregistered Sales of Equity Securities and Use of Proceeds     91  
  Other Information     91  
  Exhibits     91  
    92  
    93  
 Exhibit 12.1
 Exhibit 31.1
 Exhibit 31.1.2
 Exhibit 31.2
 Exhibit 32
 Exhibit 99.1
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT


2


Table of Contents

CapitalSource Inc.
 
 
                 
    June 30,
    December 31,
 
    2011     2010  
    (Unaudited)        
    ($ in thousands)  
 
ASSETS
Cash and cash equivalents
  $ 1,581,266     $ 820,450  
Restricted cash (including $54.3 million and $46.5 million, respectively, of cash that can only be used to settle obligations of consolidated VIEs)
    101,256       128,586  
Investment securities:
               
Available-for-sale, at fair value
    1,472,743       1,522,911  
Held-to-maturity, at amortized cost
    136,250       184,473  
                 
Total investment securities
    1,608,993       1,707,384  
Loans:
               
Loans held for sale
    119,247       205,334  
Loans held for investment
    5,482,736       6,152,876  
Less deferred loan fees and discounts
    (77,591 )     (106,438 )
Less allowance for loan losses
    (199,138 )     (329,122 )
                 
Loans held for investment, net (including $670.3 million and $889.7 million, respectively, of loans that can only be used to settle obligations of consolidated VIEs)
    5,206,007       5,717,316  
                 
Total loans
    5,325,254       5,922,650  
Interest receivable
    38,117       57,393  
Other investments
    61,665       71,889  
Goodwill
    173,135       173,135  
Other assets
    425,258       563,920  
                 
Total assets
  $ 9,314,944     $ 9,445,407  
                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
               
Deposits
  $ 4,785,790     $ 4,621,273  
Credit facilities
          67,508  
Term debt (including $410.6 million and $693.5 million, respectively, in obligations of consolidated VIEs for which there is no recourse to the general credit of CapitalSource Inc.)
    697,910       979,254  
Other borrowings
    1,451,983       1,375,884  
Other liabilities
    268,911       347,546  
                 
Total liabilities
    7,204,594       7,391,465  
Shareholders’ equity:
               
Preferred stock (50,000,000 shares authorized; no shares outstanding)
           
Common stock ($0.01 par value, 1,200,000,000 shares authorized; 323,179,426 and 323,225,355 shares issued and outstanding, respectively)
    3,232       3,232  
Additional paid-in capital
    3,917,731       3,911,341  
Accumulated deficit
    (1,857,311 )     (1,870,572 )
Accumulated other comprehensive income, net
    46,698       9,941  
                 
Total shareholders’ equity
    2,110,350       2,053,942  
                 
Total liabilities and shareholders’ equity
  $ 9,314,944     $ 9,445,407  
                 
 
See accompanying notes.


3


Table of Contents

CapitalSource Inc.
 
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2011     2010     2011     2010  
    (Unaudited)
 
    ($ in thousands, except per share data)  
 
Net interest income:
                               
Interest income:
                               
Loans
  $ 113,647     $ 148,797     $ 237,147     $ 305,047  
Investment securities
    12,688       15,619       31,040       30,210  
Other
    1,090       304       1,390       877  
                                 
Total interest income
    127,425       164,720       269,577       336,134  
Interest expense:
                               
Deposits
    13,398       15,279       26,781       31,637  
Borrowings
    32,409       45,478       65,778       94,121  
                                 
Total interest expense
    45,807       60,757       92,559       125,758  
                                 
Net interest income
    81,618       103,963       177,018       210,376  
Provision for loan losses
    1,523       25,262       46,332       244,202  
                                 
Net interest income (loss) after provision for loan losses
    80,095       78,701       130,686       (33,826 )
Operating expenses:
                               
Compensation and benefits
    29,098       29,423       59,477       63,606  
Professional fees
    10,914       8,497       18,102       18,867  
Other administrative expenses
    15,310       15,671       32,004       34,323  
                                 
Total operating expenses
    55,322       53,591       109,583       116,796  
Other income (expense):
                               
Gain on investments, net
    8,725       10,257       32,240       16,336  
Loss on derivatives
    (271 )     (3,614 )     (2,149 )     (7,951 )
Net expense of real estate owned and other foreclosed assets
    (10,355 )     (43,175 )     (20,528 )     (83,667 )
Other income, net
    10,971       1,726       17,498       18,201  
                                 
Total other income (expense)
    9,070       (34,806 )     27,061       (57,081 )
                                 
Net income (loss) from continuing operations before income taxes
    33,843       (9,696 )     48,164       (207,703 )
Income tax expense (benefit)
    17,249       (4,174 )     28,411       16,832  
                                 
Net income (loss) from continuing operations
    16,594       (5,522 )     19,753       (224,535 )
Net income from discontinued operations, net of taxes
          2,166             9,489  
Net gain from sale of discontinued operations, net of taxes
          21,696             21,696  
                                 
Net income (loss)
  $ 16,594     $ 18,340     $ 19,753     $ (193,350 )
                                 
Basic income (loss) per share:
                               
From continuing operations
  $ 0.05     $ (0.02 )   $ 0.06     $ (0.70 )
From discontinued operations
  $     $ 0.08     $     $ 0.10  
Net income (loss) per share
  $ 0.05     $ 0.06     $ 0.06     $ (0.60 )
Diluted income (loss) per share:
                               
From continuing operations
  $ 0.05     $ (0.02 )   $ 0.06     $ (0.70 )
From discontinued operations
  $     $ 0.08     $     $ 0.10  
Net income (loss) per share
  $ 0.05     $ 0.06     $ 0.06     $ (0.60 )
Average shares outstanding:
                               
Basic
    320,426,484       320,802,358       320,311,588       320,547,818  
Diluted
    327,087,717       320,802,358       327,025,588       320,547,818  
Dividends declared per share
  $ 0.01     $ 0.01     $ 0.02     $ 0.02  
 
See accompanying notes.


4


Table of Contents

CapitalSource Inc.
 
 
                                         
                      Accumulated
       
          Additional
          Other
    Total
 
    Common
    Paid-in
    Accumulated
    Comprehensive
    Shareholders’
 
    Stock     Capital     Deficit     Income, net     Equity  
    (Unaudited)
 
    ($ in thousands)  
 
Total shareholders’ equity as of December 31, 2010
  $ 3,232     $ 3,911,341     $ (1,870,572 )   $ 9,941     $ 2,053,942  
Net income
                19,753             19,753  
Other comprehensive income:
                                       
Unrealized gain, net of tax
                      36,757       36,757  
                                         
Total comprehensive income
                                    56,510  
Dividends paid
          45       (6,492 )           (6,447 )
Stock option expense
          3,026                   3,026  
Exercise of options
    2       802                   804  
Restricted stock activity
    (2 )     2,517                   2,515  
                                         
Total shareholders’ equity as of June 30, 2011
  $ 3,232     $ 3,917,731     $ (1,857,311 )   $ 46,698     $ 2,110,350  
                                         
 
See accompanying notes.


5


Table of Contents

CapitalSource Inc.
 
 
                 
    Six Months Ended
 
    June 30,  
    2011     2010  
    (Unaudited)
 
    ($ in thousands)  
 
Operating activities:
               
Net income (loss)
  $ 19,753     $ (193,350 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Stock option expense
    3,026       2,402  
Restricted stock expense
    3,511       6,141  
Gain on extinguishment of debt
          (1,096 )
Amortization of deferred loan fees and discounts
    (40,869 )     (38,771 )
Paid-in-kind interest on loans
    29,804       6,143  
Provision for loan losses
    46,332       244,202  
Provision for unfunded commitments
          (510 )
Amortization of deferred financing fees and discounts
    15,956       30,925  
Depreciation and amortization
    74       523  
Provision for deferred income taxes
    50,354       25,066  
Non-cash (gain) loss on investments, net
    (35,708 )     478  
Gain on assets acquired through business combination
          (3,724 )
Non-cash loss on foreclosed assets and other property and equipment disposals
    17,765       57,302  
Unrealized loss (gain) on derivatives and foreign currencies, net
    2,130       (13,110 )
Accretion of discount on commercial real estate “A” participation interest
          (8,222 )
Decrease in interest receivable
    19,276       20,367  
Decrease in loans held for sale, net
    200,950       7,507  
Decrease (increase) in other assets
    72,029       (6,095 )
Decrease in other liabilities
    (76,566 )     (35,537 )
                 
Cash provided by operating activities
    327,817       100,641  
Investing activities:
               
Decrease in restricted cash
    27,330       26,125  
Decrease in commercial real estate “A” participation interest, net
          368,324  
Decrease in loans, net
    364,546       343,501  
Assets acquired through business combination, net of cash acquired
          (98,800 )
Cash received for real estate
          339,643  
Reduction (acquisition) of marketable securities, available for sale, net
    94,790       (542,526 )
Reduction of marketable securities, held to maturity, net
    54,689       46,304  
Reduction of other investments, net
    23,683       20,352  
Acquisition of property and equipment, net
    (7,094 )     (757 )
                 
Cash provided by investing activities
    557,944       502,166  
Financing activities:
               
Payment of deferred financing fees
          (4,430 )
Deposits accepted, net of repayments
    164,517       86,892  
Repayments on credit facilities, net
    (68,792 )     (206,696 )
Borrowings of term debt
          14,784  
Repayments and extinguishment of term debt
    (282,985 )     (710,160 )
Borrowings under (repayments of) other borrowings
    67,958       (233,154 )
Proceeds from exercise of options
    804       347  
Payment of dividends
    (6,447 )     (6,485 )
                 
Cash used in financing activities
    (124,945 )     (1,058,902 )
                 
Increase (decrease) in cash and cash equivalents
    760,816       (456,095 )
Cash and cash equivalents as of beginning of period
    820,450       1,177,020  
                 
Cash and cash equivalents as of end of period
  $ 1,581,266     $ 720,925  
                 
Supplemental information:
               
Noncash transactions from investing and financing activities:
               
Third-party assumption of debt
  $     $ 203,679  
Assets acquired through foreclosure
    10,911       74,643  
 
See accompanying notes.


6


Table of Contents

 
Note 1.   Organization
 
References to we, us, the Company or CapitalSource refer to CapitalSource Inc., a Delaware corporation, together with its subsidiaries. References to CapitalSource Bank include its subsidiaries, and references to Parent Company refer to CapitalSource Inc. and its subsidiaries other than CapitalSource Bank. We are a commercial lender that, primarily through our wholly owned subsidiary, CapitalSource Bank, provides financial products to small and middle market businesses nationwide and provides depository products and services in southern and central California.
 
For the three and six months ended June 30, 2011, we operated as two reportable segments: 1) CapitalSource Bank and 2) Other Commercial Finance. For the three and six months ended June 30, 2010, we operated as three reportable segments: 1) CapitalSource Bank, 2) Other Commercial Finance, and 3) Healthcare Net Lease. Our CapitalSource Bank segment comprises our commercial lending and banking business activities, and our Other Commercial Finance segment comprises our loan portfolio and other business activities in the Parent Company. Our Healthcare Net Lease segment comprised our direct real estate investment business activities, which we exited completely with the sale of all of the assets related to this segment during 2010, and consequently, we have presented the financial condition and results of operations within our Healthcare Net Lease segment as discontinued operations for all periods presented. We have reclassified all comparative period results to reflect our two current reportable segments. For additional information, see Note 19, Segment Data.
 
Note 2.   Summary of Significant Accounting Policies
 
 
Our interim consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934. Accordingly, certain disclosures accompanying annual consolidated financial statements prepared in accordance with GAAP are omitted. In the opinion of management, all adjustments and eliminations, consisting solely of normal recurring accruals, considered necessary for the fair presentation of financial statements for the interim periods, have been included. The current period’s results of operations are not necessarily indicative of the results that ultimately may be achieved for the year. The interim consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the Securities and Exchange Commission on February 28, 2011 (“Form 10-K”).
 
The accompanying financial statements reflect our consolidated accounts and those of other entities in which we have a controlling financial interest including our majority-owned subsidiaries and variable interest entities (“VIEs”) for which we determined that we are the primary beneficiary. All significant intercompany accounts and transactions have been eliminated.
 
 
Certain amounts in prior period consolidated financial statements have been reclassified to conform to the current period presentation, including the reclassification of fee income to interest income or other income, net and the reclassification of letter of credit fee expense from interest expense to other income, net in our audited consolidated statements of operations. Accordingly, the reclassifications have been appropriately reflected throughout our consolidated financial statements.
 
Except as discussed below, our accounting policies are described in Note 2, Summary of Significant Accounting Policies, of our audited consolidated financial statements as of December 31, 2010, included in our Form 10-K.


7


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
In January 2010, the Financial Accounting Standards Board (“FASB”) amended its guidance on fair value measurements and disclosure, which was intended to improve transparency in financial reporting by requiring enhanced disclosures related to fair value measurements. These new disclosures provided for disclosure of transfers between Level 1 and Level 2 of the fair value hierarchy, of fair value measurements for each class of assets and liabilities presented, of separate information for acquisitions, sales, issuances, and settlements in the rollforward of activity of Level 3 fair value measurements, and of valuation techniques used in recurring and nonrecurring fair value measurements for both Level 2 and Level 3 measurements. We adopted this guidance on January 1, 2010, except for the guidance related to acquisitions, sales, issuances, and settlements in the rollforward of activity of Level 3 fair value measurements, which is effective for annual reporting periods ending after December 15, 2010, and for interim periods within those annual reporting periods. We adopted the guidance related to the rollforward of activity of Level 3 fair value measurements on January 1, 2011, and it did not have a material impact on our consolidated financial statements.
 
In July 2010, the FASB amended its guidance on financing receivables to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment and class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. This guidance was effective for interim and annual periods ending on or after December 15, 2010 for disclosures as of the end of a period and for interim and annual periods beginning after December 15, 2010 for disclosures related to activity during a period. We adopted the guidance for disclosures as of the end of a period on October 1, 2010 and for disclosures related to activity during a period on January 1, 2011. For further information, see Note 5, Loans and Credit Quality.
 
In April 2011, the FASB amended its guidance on loans to clarify which loan modifications constitute troubled debt restructurings. It is intended to assist creditors in determining whether a modification of the terms of a receivable meets the criteria to be considered a troubled debt restructuring, both for purposes of recording an impairment loss and for disclosure of troubled debt restructurings. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: (a) the restructuring constitutes a concession; and (b) the debtor is experiencing financial difficulties. This guidance is effective for interim and annual periods beginning on or after June 15, 2011, and applies retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption. We adopted this guidance as of July 1, 2011, and we anticipate that the adoption will not have a material impact on our consolidated financial statements.
 
In May 2011, the FASB amended its guidance on fair value measurements to achieve common disclosure requirements for GAAP and International Financial Accounting Standards (“IFRS”). The amendments clarify existing GAAP requirements for fair value measurements and eliminate wording differences between current GAAP and IFRS guidelines. This guidance is effective for interim and annual periods beginning after December 15, 2011. We plan to adopt this guidance as of January 1, 2012, and we anticipate that the adoption will not have a material impact on our consolidated financial statements.
 
In June 2011, the FASB amended its guidance on the presentation of comprehensive income. This guidance eliminates the option to report other comprehensive income and its components in the consolidated statement of shareholders’ equity. An entity may elect to present items of net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income, or in two separate, but consecutive, statements. Each component of net income and of other comprehensive income needs to be displayed under either alternative. This guidance is effective for interim and annual periods beginning after December 15, 2011. We plan to adopt this guidance as of January 1, 2012, and we anticipate that the adoption will not have a material impact on our consolidated financial statements.


8


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Note 3.   Discontinued Operations
 
In 2010, we completed the sale of our long-term healthcare facilities, and as a result, we exited the skilled nursing home ownership business. Consequently, we have presented the results of operations for this business as discontinued operations for all periods presented. Additionally, the results of the discontinued operations include the activities of other healthcare facilities that have been sold since the inception of the business.
 
The condensed statements of operations for the three and six months ended June 30, 2011 and 2010 for our discontinued operations were as follows:
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2011     2010     2011     2010  
    ($ in thousands)  
 
Revenue:
                               
Operating lease income
  $     $ 13,484     $     $ 28,750  
Expenses:
                               
Interest
          10,670             15,183  
Depreciation
                      2,540  
General and administrative
          658             1,481  
Other (income) expense
          (10 )           57  
                                 
Total expenses
          11,318             19,261  
Gain from sale of discontinued operations
          21,696             21,696  
                                 
Net income attributable to discontinued operations
  $     $ 23,862     $     $ 31,185  
                                 
 
Note 4.   Cash and Cash Equivalents and Restricted Cash
 
As of June 30, 2011 and December 31, 2010, our cash and cash equivalents and restricted cash balances were as follows:
 
                                 
    June 30, 2011     December 31, 2010  
    Unrestricted     Restricted     Unrestricted     Restricted  
    ($ in thousands)  
 
Cash and cash equivalents and restricted cash:
                               
Cash and due from banks(1)
  $ 257,618     $ 46,882     $ 576,276     $ 58,814  
Interest-bearing deposits in other banks(2)
    147,667             70,383       10,213  
Other short-term investments(3)
    1,175,981       54,374       173,791       59,559  
                                 
Total cash and cash equivalents and restricted cash
  $ 1,581,266     $ 101,256     $ 820,450     $ 128,586  
                                 
 
 
(1) Represents principal and interest collections, including those related to loans held by securitization trusts or pledged to financing sources.
 
(2) Represents principal and interest collections on loan assets pledged to financing sources. Included in these balances for CapitalSource Bank were $83.1 million and $63.6 million in deposits at the Federal Reserve Bank (“FRB”) as of June 30, 2011 and December 31, 2010, respectively.
 
(3) Represents principal and interest collections, including those related to loans held by securitization trusts or pledged to financing sources and also includes short-term investments held by CapitalSource Bank. Cash is invested in short term investment grade commercial paper which is rated by at least two of the three major rating agencies (S&P, Moody’s or Fitch) and has a rating of A1 (S&P) P1 (Moody’s) or F1 (Fitch) and in a short-term money market fund which has a rating of AAAm (S&P) and Aaa (Moody’s).


9


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Note 5.   Loans and Credit Quality
 
As of June 30, 2011 and December 31, 2010, our outstanding loan balance was $5.6 billion and $6.4 billion, respectively. Included in these amounts were loans held for sale and loans held for investment. As of June 30, 2011 and December 31, 2010, interest and fee receivables totaled $33.6 million and $52.7 million, respectively.
 
 
We determine when to sell a loan on a loan-by-loan basis and consider several factors, including the credit quality of the loan, any financing secured by the loan and any requirements related to the release of liens and use of sales proceeds, the potential sale price relative to our loan valuation, our liquidity needs, and the resources necessary to ensure an adequate recovery if we continued to hold the loan. When our analysis indicates that the proper strategy is to sell a loan, we initiate the sale process and designate the loan as held for sale.
 
During the three months ended June 30, 2011 and 2010, we transferred to held for sale, from held for investment, loans with a carrying value of $135.4 million, all of which were impaired, and $55.2 million, of which $41.7 million were impaired, respectively. These transfers were based on our decision to sell these loans as part of overall portfolio management and workout strategies. We incurred $1.4 million and $7.5 million of losses due to valuation adjustments at the time of transfer during the three months ended June 30, 2011 and 2010, respectively. We did not reclassify any loans from held for sale to held for investment during the three months ended June 30, 2011 and 2010, respectively.
 
During the six months ended June 30, 2011 and 2010, we transferred to held for sale, from held for investment, loans with a carrying value of $165.7 million, all of which were impaired, and $92.8 million, of which $70.7 million were impaired, respectively. We incurred $1.4 million and $7.5 million of losses due to valuation adjustments at the time of transfer for the six months ended June 30, 2011 and 2010, respectively. We reclassified $28.6 million and $10.5 million of loans from held for sale to held for investment during the six months ended June 30, 2011 and 2010, respectively, based upon our intent to retain these loans for investment.
 
During the three and six months ended June 30, 2011, we recognized net pre-tax gains of $3.1 million and $4.4 million, respectively, related to sales of loans. During the three and six months ended June 30, 2010, we recognized net pre-tax losses of $7.6 million and $7.5 million, respectively, related to sales of loans.
 
As of June 30, 2011 and December 31, 2010, loans held for sale with an outstanding balance of $118.7 million and $14.7 million, respectively, were classified as non-accrual loans. We did not record any fair value write-downs on non-accrual loans held for sale during the three and six months ended June 30, 2011. We recorded $5.6 million in fair value write-downs on non-accrual loans held for sale during the three and six months ended June 30, 2010.
 
 
Loans held for investment are recorded at the principal amount outstanding, net of deferred loan costs or fees and any discounts received or premiums paid on purchased loans. We maintain an allowance for loan and lease losses for loans held for investment, which is calculated based on management’s estimate of incurred loan losses inherent in our loan portfolio as of the balance sheet date. This methodology is used consistently to develop our allowance for loan losses for all loans in our loan portfolio, and, as such, we maintain a single portfolio segment. The loans in our portfolio are grouped into seven loan classes, based on the level that we use to assess and monitor the risk and performance of the portfolio, including the nature of the borrower, collateral and lending arrangement.
 
Non-performing loans are loans accounted for on a non-accrual basis, accruing loans which are contractually past due 90 days or more as to principal or interest payments and other loans identified as troubled debt restructurings (“TDRs”) as defined by GAAP.
 
During the three and six months ended June 30, 2011, we purchased loans held for investment with an unpaid principal balance of $32.0 million and $347.3 million, respectively. As of June 30, 2011 and December 31, 2010, the


10


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
carrying value of each class of loans held for investment, separated by performing and non-performing categories, was as follows:
 
                                                 
    June 30, 2011     December 31, 2010  
Class   Performing     Non-Performing     Total     Performing     Non-Performing     Total  
    ($ in thousands)  
 
Asset-based
  $ 1,057,201     $ 112,346     $ 1,169,547     $ 1,352,039     $ 194,625     $ 1,546,664  
Cash flow
    1,619,384       204,656       1,824,040       1,558,783       264,786       1,823,569  
Healthcare asset-based
    252,910       2,101       255,011       269,339       2,925       272,264  
Healthcare real estate
    480,176       27,328       507,504       841,774       28,866       870,640  
Multi-family
    722,564       1,811       724,375       328,300       11,010       339,310  
Real estate
    594,696       192,290       786,986       725,972       356,087       1,082,059  
Small business
    126,657       11,025       137,682       101,761       10,171       111,932  
                                                 
Total(1)
  $ 4,853,588     $ 551,557     $ 5,405,145     $ 5,177,968     $ 868,470     $ 6,046,438  
                                                 
 
 
(1) Excludes loans held for sale. Balances are net of deferred loan fees and discounts.
 
As of June 30, 2011 and December 31, 2010, CapitalSource Bank pledged loans held for investment with an unpaid principal balance of $367.2 million and $166.1 million, respectively, to the Federal Home Loan Bank of San Francisco (“FHLB SF”) as collateral for its financing facility.
 
Credit risk within our loan portfolio is the risk of loss arising from adverse changes in a client’s or counterparty’s ability to meet its financial obligations under agreed-upon terms. The degree of credit risk will vary based on many factors including the size of the asset or transaction, the credit characteristics of the client, the contractual terms of the agreement and the availability and quality of collateral.
 
We use a variety of tools to continuously monitor a client’s ability to perform under its obligations. Additionally, we syndicate loan exposure to other lenders, sell loans and use other risk mitigation techniques to manage the size and risk profile of our loan portfolio.
 
Credit risk management for the loan portfolio begins with an assessment of the credit risk profile of a client generally based on an analysis of the client’s payment performance, cash flow and financial position. As part of the overall credit risk assessment of a client, each credit exposure is assigned an internal risk rating that is subject to approval based on defined credit approval standards. While rating criteria vary by product, each loan rating focuses on the same two factors: financial performance and collateral. Subsequent to loan origination, risk ratings are monitored on an ongoing basis. If necessary, risk ratings are adjusted to reflect changes in the client’s financial condition, cash flow or financial position. We use risk rating aggregations to measure and evaluate concentrations within the loan portfolio. In making decisions regarding credit, we consider risk rating, collateral and industry concentration limits.
 
We believe that the likelihood of not being paid according to the contractual terms of a loan is, in large part, dependent upon the assessed level of risk associated with the loan. The internal rating that is assigned to a loan provides a view as to the relative risk of each loan. We employ an internal risk rating scale to establish a view of the credit quality of each loan. This scale is based on the credit classifications of assets as prescribed by government regulations and industry standards and is separated into the following groups:
 
  •  Pass — Loans with standard, acceptable levels of credit risk;
 
  •  Special mention — Loans that have potential weaknesses that deserve close attention, and which, if left uncorrected, may result in a loss or deterioration of our credit position;


11


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
  •  Substandard — Loans that are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected; and
 
  •  Doubtful — Loans that have all the weaknesses inherent in those classified as Substandard with the added characteristic that the weaknesses make collection or liquidation in full improbable based on currently existing facts, conditions, and values.
 
As of June 30, 2011 and December 31, 2010, the carrying value of each class of loans held for investment, by internal risk rating, was as follows:
 
                                         
    Internal Risk Rating        
Class   Pass     Special Mention     Substandard     Doubtful     Total  
    ($ in thousands)  
 
As of June 30, 2011:
                                       
Asset-based
  $ 856,917     $ 140,533     $ 99,366     $ 72,731     $ 1,169,547  
Cash flow
    1,313,942       84,324       382,544       43,230       1,824,040  
Healthcare asset-based
    216,726       28,879       8,391       1,015       255,011  
Healthcare real estate
    417,998       40,362       44,978       4,166       507,504  
Multi-family
    714,939       4,463       3,162       1,811       724,375  
Real estate
    397,966       38,395       248,843       101,782       786,986  
Small business
    121,607       3,918       7,497       4,660       137,682  
                                         
Total(1)
  $ 4,040,095     $ 340,874     $ 794,781     $ 229,395     $ 5,405,145  
                                         
As of December 31, 2010:
                                       
Asset-based
  $ 1,207,990     $ 39,612     $ 169,986     $ 129,076     $ 1,546,664  
Cash flow
    1,110,779       216,399       350,287       146,104       1,823,569  
Healthcare asset-based
    245,486       9,243       15,509       2,026       272,264  
Healthcare real estate
    773,955       37,730       47,090       11,865       870,640  
Multi-family
    330,017             8,919       374       339,310  
Real estate
    396,044       98,401       470,034       117,580       1,082,059  
Small business
    97,444       6,278       5,514       2,696       111,932  
                                         
Total(1)
  $ 4,161,715     $ 407,663     $ 1,067,339     $ 409,721     $ 6,046,438  
                                         
 
 
(1) Excludes loans held for sale. Balances are net of deferred loan fees and discounts.
 
Non-Accrual and Past Due Loans
 
We will place a loan on non-accrual status if there is substantial doubt about the borrower’s ability to service its debt and other obligations or if the loan is 90 or more days past due and is not well-secured and in the process of collection. When a loan is placed on non-accrual status, accrued and unpaid interest is reversed and the recognition of interest and fee income on that loan will stop until factors no longer indicate collection is doubtful and the loan has been brought current. Payments received on non-accrual loans are generally first applied to principal. A loan may be returned to accrual status when its interest or principal is current, repayment of the remaining contractual principal and interest is expected or when the loan otherwise becomes well-secured and is in the process of collection. Cash payments received from the borrower and applied to the principal balance of the loan while the loan was on non-accrual status are not reversed if a loan is returned to accrual status.


12


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
As of June 30, 2011 and December 31, 2010, the carrying value of non-accrual loans was as follows:
 
                 
    June 30, 2011     December 31, 2010  
    ($ in thousands)  
 
Asset-based
  $ 73,820     $ 142,847  
Cash flow
    113,996       183,606  
Healthcare asset-based
    2,101       2,925  
Healthcare real estate
    27,328       28,866  
Multi-family
    1,811       11,010  
Real estate
    110,274       265,615  
Small business
    5,997       4,980  
                 
Total(1)
  $ 335,327     $ 639,849  
                 
 
 
(1) Excludes loans held for sale and purchased credit impaired loans. Balances are net of deferred loan fees and discounts.
 
As of June 30, 2011 and December 31, 2010, the delinquency status of loans in our loan portfolio was as follows:
 
                                                 
                                  Greater than 90
 
    30-89 Days
    Greater than 90
                      Days Past Due and
 
    Past Due     Days Past Due     Total Past Due     Current     Total Loans     Accruing  
    ($ in thousands)  
 
As of June 30, 2011:
                                               
Asset-based
  $     $ 20,424     $ 20,424     $ 1,142,382     $ 1,162,806     $ 1,982  
Cash flow
    751       36,304       37,055       1,786,985       1,824,040        
Healthcare asset-based
                      255,011       255,011        
Healthcare real estate
          21,167       21,167       483,430       504,597        
Multi-family
    205       349       554       723,821       724,375        
Real estate
          91,579       91,579       692,950       784,529       37,870  
Small business
    2,297       4,606       6,903       125,751       132,654        
                                                 
Total(1)
  $ 3,253     $ 174,429     $ 177,682     $ 5,210,330     $ 5,388,012     $ 39,852  
                                                 
As of December 31, 2010:
                                               
Asset-based
  $ 8,074     $ 27,130     $ 35,204     $ 1,500,537     $ 1,535,741     $ 3,244  
Cash flow
    10,573       60,644       71,217       1,752,352       1,823,569        
Healthcare asset-based
                      272,264       272,264        
Healthcare real estate
          25,887       25,887       840,527       866,414        
Multi-family
    2,324       9,293       11,617       327,692       339,309        
Real estate
    54       148,197       148,251       924,590       1,072,841       45,783  
Small business
    4,317       4,981       9,298       97,444       106,742        
                                                 
Total(1)
  $ 25,342     $ 276,132     $ 301,474     $ 5,715,406     $ 6,016,880     $ 49,027  
                                                 
 
 
(1) Excludes loans held for sale and purchased credit impaired loans. Balances are net of deferred loan fees and discounts.
 
Impaired Loans
 
We consider a loan to be impaired when, based on current information, we determine that it is probable that we will be unable to collect all amounts due in accordance with the contractual terms of the original loan agreement. In this regard, impaired loans include loans where we expect to encounter a significant delay in the collection of and/or a shortfall in the amount of contractual payments due to us.


13


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Assessing the likelihood that a loan will not be paid according to its contractual terms involves the consideration of all relevant facts and circumstances and requires a significant amount of judgment. For such purposes, factors that are considered include:
 
  •  The current performance of the borrower;
 
  •  The current economic environment and financial capacity of the borrower to preclude a default;
 
  •  The willingness of the borrower to provide the support necessary to preclude a default (including the potential for successful resolution of a potential problem through modification of terms); and
 
  •  The borrower’s equity position in, and the value of, the underlying collateral, if applicable, based on our best estimate of the fair value of the collateral.
 
In assessing the adequacy of available evidence, we consider whether the receipt of payments is dependent on the fiscal health of the borrower or the sale, refinancing or foreclosure of the loan.
 
We continue to recognize interest income on loans that have been identified as impaired but that have not been placed on non-accrual status.
 
As of June 30, 2011 and December 31, 2010, information pertaining to our impaired loans was as follows:
 
                                                 
    June 30, 2011     December 31, 2010  
    Carrying
    Legal Principal
    Related
    Carrying
    Legal Principal
    Related
 
    Value(1)     Balance(2)     Allowance     Value(1)     Balance(2)     Allowance  
    ($ in thousands)  
 
With no related allowance recorded:
                                               
Asset-based
  $ 68,304     $ 88,150     $     $ 96,514     $ 180,659     $  
Cash flow
    125,586       207,183             128,658       205,454        
Healthcare asset-based
    876       1,127             463       825        
Healthcare real estate
    27,328       33,826             18,881       19,892        
Multi-family
    1,606       2,616             11,010       15,402        
Real estate
    96,143       162,732             323,292       407,423        
Small business
    9,354       17,182             9,861       17,708        
                                                 
Total(1)
    329,197       512,816             588,679       847,363        
With allowance recorded:
                                               
Asset-based
    44,041       59,899       (6,246 )     98,762       112,732       (21,684 )
Cash flow
    79,070       104,847       (8,136 )     142,171       191,172       (33,069 )
Healthcare asset-based
    1,226       11,913       (467 )     2,462       11,614       (675 )
Healthcare real estate
                      9,984       11,278       (2,323 )
Multi-family
    205       279       (19 )                  
Real estate
    22,819       45,308       (2,502 )     69,128       92,833       (21,076 )
Small business
    1,670       1,826       (490 )     310       359       (141 )
                                                 
Total(1)
    149,031       224,072       (17,860 )     322,817       419,988       (78,968 )
                                                 
Total impaired loans
  $ 478,228     $ 736,888     $ (17,860 )   $ 911,496     $ 1,267,351     $ (78,968 )
                                                 
 
 
(1) Carrying value of impaired loans before applying specific reserves. Excludes loans held for sale. Balances are net of deferred loan fees and discounts.
 
(2) Represents the contractual amounts owed to us by borrowers.


14


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
Average balances and interest income recognized on impaired loans by loan class for the three and six months ended June 30, 2011 and 2010 were as follows:
 
                                                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
    Average
    Interest Income
    Average
    Interest Income
    Average
    Interest Income
    Average
    Interest Income
 
    Balance     Recognized(1)     Balance     Recognized(1)     Balance     Recognized(1)     Balance     Recognized(1)  
    ($ in thousands)  
 
No allowance recorded:
                                                               
Asset-based
  $ 69,557     $ 622     $ 180,428     $ 1,774     $ 75,611     $ 1,392     $ 153,946     $ 3,396  
Cash flow
    115,414       2,501       176,717       1,325       122,127       3,721       221,047       4,012  
Healthcare asset-based
    1,421       101       3,930             1,002       101       2,327       131  
Healthcare real estate
    21,852       165       22,128             20,579       165       20,902        
Multi-family
    7,198             140             8,813             315        
Real estate
    188,509       1,245       202,883       2,283       246,797       2,921       141,697       2,352  
Small business
    10,129                         10,014                    
                                                                 
Total
    414,080       4,634       586,226       5,382       484,943       8,300       540,234       9,891  
With allowance recorded:
                                                               
Asset-based
    41,694             54,632             61,933             52,334        
Cash flow
    126,335       831       123,235       210       137,642       1,663       98,987       545  
Healthcare asset-based
    811             5,233             1,429             5,428        
Healthcare real estate
    8,802             13,583       90       9,296             9,698       180  
Multi-family
    1,242             15,716             710             18,078        
Real estate
    31,509             528,715             45,901             539,390       201  
Small business
    511                         425                    
                                                                 
Total
    210,904       831       741,114       300       257,336       1,663       723,915       926  
                                                                 
Total impaired loans
  $ 624,984     $ 5,465     $ 1,327,340     $ 5,682     $ 742,279     $ 9,963     $ 1,264,149     $ 10,817  
                                                                 
 
 
(1) We recognized no cash basis interest income on impaired loans during the three months ended June 30, 2011, and we recognized $0.2 million of cash basis interest on impaired loans during the three months ended June 30, 2010. The amounts of cash basis interest income that were recognized on impaired loans were $0.1 million and $0.3 million during the six months ended June 30, 2011 and 2010, respectively.
 
As of June 30, 2011 and December 31, 2010, the carrying value of impaired loans with no related allowance recorded was $329.2 million and $588.7 million, respectively. Of these amounts, $143.2 million and $222.4 million, respectively, related to loans that were charged off to their carrying values. These charge offs were primarily the result of collateral dependent loans for which ultimate collection depends solely on the sale of the collateral. The remaining $186.0 million and $366.3 million related to loans that had no recorded charge offs or specific reserves as of June 30, 2011 and December 31, 2010, respectively, based on our estimates that we ultimately will collect all principal amounts due.
 
If our non-accrual loans had performed in accordance with their original terms, interest income would have been increased by $28.7 million and $61.7 million for the three and six months ended June 30, 2011, respectively, and $39.9 million and $79.4 million for the three and six months ended June 30, 2010, respectively.
 
 
Our allowance for loan losses represents management’s estimate of incurred loan losses inherent in our loan and lease portfolio as of the balance sheet date. The estimation of the allowance for loan losses is based on a variety of factors, including past loan loss experience, the current credit profile and financial position of our borrowers, adverse situations that have occurred that may affect the borrowers’ ability to repay, the estimated value of underlying collateral and general economic conditions. Provisions for loan losses are recognized when available


15


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
information indicates that it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated.
 
We perform quarterly and systematic detailed reviews of our loan portfolio to identify credit risks and to assess the overall collectability of the portfolio. The allowance on certain pools of loans with similar characteristics is estimated using reserve factors that are reflective of historical loss rates.
 
Our portfolio is reviewed regularly, and, on a periodic basis, individual loans are reviewed and assigned a risk rating. Loans subject to individual reviews are analyzed and segregated by risk according to our internal risk rating scale. These risk ratings, in conjunction with an analysis of historical loss experience, current economic conditions, industry performance trends, and any other pertinent information, including individual valuations on impaired loans, are factored in the estimation of the allowance for loan losses. The historical loss experience is updated quarterly to incorporate the most recent data reflective of the current economic environment.
 
If the recorded investment in an impaired loan exceeds the present value of payments expected to be received, the fair value of the collateral and/or the loan’s observable market price, a specific allowance is established as a component of the allowance for loan losses.
 
When available information confirms that specific loans or portions thereof are uncollectible, these amounts are charged off against the allowance for loan losses. To the extent we later collect amounts previously charged off, we will recognize a recovery through the allowance for loan losses for the amount received.
 
We also consider whether losses may have been incurred in connection with unfunded commitments to lend. In making this assessment, we exclude from consideration those commitments for which funding is subject to our approval based on the adequacy of underlying collateral that is required to be presented by a borrower or other terms and conditions. Reserves for losses related to unfunded commitments are included within other liabilities on our audited consolidated balance sheets.
 
Activity in the allowance for loan losses related to our loans held for investment for the three and six months ended June 30, 2011 and 2010, respectively, was as follows:
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2011     2010     2011     2010  
    ($ in thousands)  
 
Balance as of beginning of period
  $ 283,274     $ 686,193     $ 329,122     $ 586,696  
Charge offs
    (83,468 )     (125,369 )     (179,930 )     (236,631 )
Recoveries
    2,563       296       15,976       302  
                                 
Net charge offs
    (80,905 )     (125,073 )     (163,954 )     (236,329 )
Charge offs upon transfer to held for sale
    (4,754 )     (7,749 )     (12,362 )     (15,936 )
Provision for loan losses
    1,523       25,262       46,332       244,202  
                                 
Balance as of end of period
  $ 199,138     $ 578,633     $ 199,138     $ 578,633  
                                 


16


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
As of June 30, 2011 and December 31, 2010, the balances of the allowance for loan losses and the carrying value of loans held for investment disaggregated by impairment methodology were as follows:
 
                                 
    June 30, 2011     December 31, 2010  
          Allowance for Loan
          Allowance for Loan
 
    Loans     Losses     Loans     Losses  
    ($ in thousands)  
 
Individually evaluated for impairment
  $ 472,337     $ (17,860 )   $ 904,466     $ (78,019 )
Collectively evaluated for impairment
    4,993,266       (181,278 )     5,217,393       (249,912 )
Acquired loans with deteriorated credit quality
    17,133             31,017       (1,191 )
                                 
Total
  $ 5,482,736     $ (199,138 )   $ 6,152,876     $ (329,122 )
                                 
 
Troubled Debt Restructurings (“TDRs”)
 
During the three and six months ended June 30, 2011, loans with an aggregate carrying value, which includes principal, deferred fees and accrued interest, of $68.7 million and $223.5 million, respectively, as of their respective restructuring dates, were involved in TDRs. During the three and six months ended June 30, 2010, loans with an aggregate carrying value of $361.0 million and $561.9 million, respectively, as of their respective restructuring dates, were involved in TDRs. Loans involved in TDRs are assessed as impaired, generally for a period of at least one year following the restructuring. A loan that has been involved in a TDR might no longer be assessed as impaired one year subsequent to the restructuring, assuming the loan performs under the restructured terms and the restructured terms were at market. As of June 30, 2011, two loans with an aggregate carrying value of $35.6 million that had been previously restructured in a TDR were not classified as impaired as they performed in accordance with the restructured terms for twelve consecutive months. As of December 31, 2010, all of our loans restructured in TDRs were classified as impaired loans.
 
The aggregate carrying values of loans that had been restructured in TDRs as of June 30, 2011 and December 31, 2010 were as follows:
 
                 
    June 30,
    December 31,
 
    2011     2010  
    ($ in thousands)  
 
Non-accrual
  $ 291,317     $ 400,851  
Accruing
    163,034       154,262  
                 
Total
  $ 454,351     $ 555,113  
                 
 
We recorded charge offs related to these restructured loans of $63.7 million and $134.4 million, respectively, for the three and six months ended June 30, 2011, and $52.4 million and $80.6 million, respectively, for the three and six months ended June 30, 2010. The specific reserves related to these loans were $11.5 million and $35.5 million as of June 30, 2011 and December 31, 2010, respectively.
 
For a loan that accrues interest immediately after that loan is restructured in a TDR, we generally do not charge off a portion of the loan as part of the restructuring. If a portion of a loan has been charged off, we will not accrue interest on the remaining portion of the loan if the charged off portion is still contractually due from the borrower. However, if the charged off portion of the loan is legally forgiven through concessions to the borrower, then the restructured loan may be placed on accrual status if the remaining contractual amounts due on the loan are reasonably assured of collection. In addition, for certain TDRs, especially those involving a commercial real estate loan, we may split the loan into an A note and a B note, placing the performing A note on accrual status and charging off the B note. For an amortizing loan with monthly payments, the borrower is required to demonstrate sustained payment performance for a minimum of six months to return a non-accrual restructured loan to accrual status.


17


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Our evaluation of whether collection of interest and principal is reasonably assured is based on the facts and circumstances of each individual borrower and our assessment of the borrower’s ability and intent to repay in accordance with the revised loan terms. We generally consider such factors as historical operating performance and payment history of the borrower, indications of support by sponsors and other interest holders, the terms of the modified loan, the value of any collateral securing the loan and projections of future performance of the borrower as part of this evaluation.
 
Foreclosed Assets
 
Real Estate Owned (“REO”)
 
When we foreclose on a real estate asset that collateralizes a loan, we record the asset at its estimated fair value less costs to sell at the time of foreclosure if the related REO is classified as held for sale. Upon foreclosure, we evaluate the asset’s fair value as compared to the loan’s carrying amount and record a charge off when the carrying amount of the loan exceeds fair value less costs to sell. For REO determined to be held for sale, subsequent valuation adjustments are recorded as a valuation allowance, which is recorded as a component of net expense of real estate owned and other foreclosed assets in our consolidated statements of operations. REO that does not meet the criteria of held for sale is classified as held for use and initially recorded at its fair value. The real estate asset is subsequently depreciated over its estimated useful life. Fair value adjustments on REO held for use are recorded only if the carrying amount of an asset is not recoverable and exceeds its fair value.
 
As of June 30, 2011 and December 31, 2010, we had $47.0 million and $92.3 million, respectively, of REO classified as held for sale, which was recorded in other assets in our consolidated balance sheets. Activity related to REO held for sale for the three and six months ended June 30, 2011 and 2010 was as follows:
 
                                 
    Three Months Ended
    Six Months Ended
 
    June 30,     June 30,  
    2011     2010     2011     2010  
    ($ in thousands)  
 
Balance as of beginning of period
  $ 70,050     $ 136,277     $ 92,265     $ 101,401  
Acquired in business combination
          2,014             2,014  
Transfers from loans held for investment and other assets
    8,840       23,765       13,589       78,331  
Fair value adjustments
    (11,080 )     (11,186 )     (13,124 )     (27,234 )
Transfers from REO held for use
                      2,850  
Real estate sold
    (20,798 )     (11,920 )     (45,718 )     (18,412 )
                                 
Balance as of end of period
  $ 47,012     $ 138,950     $ 47,012     $ 138,950  
                                 
 
During the three and six months ended June 30, 2011, we recognized gains of $1.1 million and $1.4 million, respectively, on the sales of REO held for sale as a component of net expense of real estate owned and other foreclosed assets in our consolidated statements of operations. During the three and six months ended June 30, 2010, we recognized losses of $1.1 million and $1.4 million, respectively, on the sales of REO held for sale as a component of net expense of real estate owned and other foreclosed assets in our consolidated statements of operations.
 
As of June 30, 2011 and December 31, 2010, we had $1.4 million of REO classified as held for use, which was recorded in other assets in our consolidated balance sheets. We did not recognize any impairment losses on REO classified as held for use during the three and six months ended June 30, 2011. During the three and six months ended June 30, 2010, we recognized impairment losses of $5.6 million and $10.2 million, respectively, on REO held for use as a component of net expense of real estate owned and other foreclosed assets in our consolidated statements of operations.


18


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
When we foreclose on a borrower whose underlying collateral consists of loans, we record the acquired loans at the estimated fair value less costs to sell at the time of foreclosure. At the time of foreclosure, we record charge offs when the carrying amount of the original loan exceeds the estimated fair value of the acquired loans. We may also write down or record allowances on the acquired loans subsequent to foreclosure if such loans experience additional credit deterioration. As of June 30, 2011 and December 31, 2010, we had $24.9 million and $55.8 million, respectively, of loans acquired through foreclosure, net of allowances of $0.4 million and $3.2 million, respectively, which were recorded in other assets in our consolidated balance sheets. Provision for losses and gains and losses on sales on our other foreclosed assets, which were recorded as a component of net expense of real estate owned and other foreclosed assets in our consolidated statements of operations, for the three and six months ended June 30, 2011 and 2010 were as follows:
 
                                         
    Three Months Ended
  Six Months Ended
   
    June 30,   June 30,    
    2011   2010   2011   2010    
    ($ in thousands)    
 
(Recovery) provision for losses on other foreclosed assets
  $ (398 )   $ 23,699     $ 7,405     $ 38,869          
(Losses) gains on sales of other foreclosed assets
    (32 )           1,647                
 
Note 6.   Investments
 
 
As of June 30, 2011 and December 31, 2010, our investment securities, available-for-sale were as follows:
 
                                                                 
    June 30, 2011     December 31, 2010  
          Gross
    Gross
                Gross
    Gross
       
    Amortized
    Unrealized
    Unrealized
    Fair
    Amortized
    Unrealized
    Unrealized
    Fair
 
    Cost     Gains     Losses     Value     Cost     Gains     Losses     Value  
    ($ in thousands)  
 
Agency callable notes
  $ 124,984     $ 575     $ (569 )   $ 124,990     $ 164,219     $ 418     $ (1,749 )   $ 162,888  
Agency debt
    55,918       1,046             56,964       102,263       1,167             103,430  
Agency discount notes
                            164,917       57             164,974  
Agency MBS
    1,110,767       23,456       (696 )     1,133,527       860,441       15,035       (5,321 )     870,155  
Asset-backed securities
    18,874       1,016             19,890                          
Collateralized loan obligation
    10,285       10,161             20,446       12,249                   12,249  
Corporate debt
    5,730       63       (15 )     5,778       5,013       122             5,135  
Equity security
    202       318             520       202       61             263  
Municipal bond
    3,235                   3,235                          
Non-agency MBS
    87,558       1,258       (1,203 )     87,613       112,917       1,640       (873 )     113,684  
U.S. Treasury and agency securities
    19,796             (16 )     19,780       90,587       24       (478 )     90,133  
                                                                 
Total
  $ 1,437,349     $ 37,893     $ (2,499 )   $ 1,472,743     $ 1,512,808     $ 18,524     $ (8,421 )   $ 1,522,911  
                                                                 
 
Included in investment securities, available-for-sale, were callable notes issued by Fannie Mae, Freddie Mac, the FHLB and Federal Farm Credit Bank (“Agency callable notes”), bonds issued by the Federal Home Loan Bank (“FHLB”) (“Agency debt”), discount notes issued by Fannie Mae, Freddie Mac and the FHLB (“Agency discount notes”), commercial and residential mortgage-backed securities issued and guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae (“Agency MBS”), asset-backed securities, investments in a collateralized loan obligation, corporate debt, an equity security, a municipal bond, commercial and residential mortgage-backed securities issued by non-government agencies (“Non-agency MBS”), and U.S. Treasury and agency securities.


19


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
The amortized cost and fair value of investment securities, available-for-sale that CapitalSource Bank pledged as collateral as of June 30, 2011 and December 31, 2010 were as follows:
 
                                 
    June 30, 2011     December 31, 2010  
Source   Amortized Cost     Fair Value     Amortized Cost     Fair Value  
    ($ in thousands)  
 
FHLB
  $ 764,161     $ 781,921     $ 877,766     $ 889,888  
FRB
    19,942       18,843       35,056       34,256  
Non-government Correspondent Bank(1)
    39,992       39,992       37,979       37,989  
Government Agency(2)
    27,651       28,512       29,069       29,305  
                                 
Total
  $ 851,746     $ 869,268     $ 979,870     $ 991,438  
                                 
 
 
(1) Represents the amounts CapitalSource Bank pledged as collateral for letters of credit and foreign exchange contracts.
 
(2) Represents the amounts CapitalSource Bank pledged as collateral to secure funds deposited by a local government agency.
 
Realized gains or losses resulting from the sale of investments are calculated using the specific identification method and are included in gain on investments, net in our consolidated statements of operations. Proceeds and gross pre-tax gains from sales of investment securities, available-for-sale for the three and six months ended June 30, 2011 and 2010 were as follows:
 
                                 
    Three Months Ended June 30,   Six Months Ended June 30,
    2011   2010   2011   2010
    ($ in thousands)
 
Proceeds from sales
  $     —     $ 19,500     $ 70,206     $ 39,500  
Gross pre-tax gains from sales
          877       14,507       1,616  
 
During the three and six months ended June 30, 2011, we recognized $10.4 million and $15.3 million, respectively, of net unrealized after-tax gains, related to our investment securities, available-for-sale, as a component of accumulated other comprehensive income, net in our consolidated balance sheets.
 
During the six months ended June 30, 2011, we recorded $1.5 million of other-than-temporary impairments (“OTTI”) on our investment securities, available-for-sale, included as a component of gain on investments, net, in our consolidated statements of operations, related to a decline in the fair value of one municipal bond. We did not record any OTTI during the three months ended June 30, 2011. We recorded no OTTI during the three months ended June 30, 2010, and $0.3 million of OTTI during the six months ended June 30, 2010, as a component of gain on investments, net in our consolidated statements of operations, related to a decline in the fair value of our equity security.
 
 
Investment securities, held-to-maturity consists of commercial mortgage-backed securities rated AAA held by CapitalSource Bank. The amortized costs and estimated fair values of the investment securities, held-to-maturity, that CapitalSource Bank pledged as collateral as of June 30, 2011 and December 31, 2010 were as follows:
 
                                 
    June 30, 2011     December 31, 2010  
Source   Amortized Cost     Fair Value     Amortized Cost     Fair Value  
    ($ in thousands)  
 
FHLB
  $ 12,178     $ 13,175     $ 21,260     $ 22,431  
FRB
    113,018       118,109       143,927       153,756  
                                 
Total
  $ 125,196     $ 131,284     $ 165,187     $ 176,187  
                                 


20


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
Unrealized Losses on Investment Securities
 
As of June 30, 2011 and December 31, 2010, the gross unrealized losses and fair values of investment securities that were in unrealized loss positions were as follows:
 
                                                 
    Less Than 12 Months     12 Months or More     Total  
    Gross
          Gross
          Gross
       
    Unrealized
    Fair
    Unrealized
    Fair
    Unrealized
    Fair
 
    Losses     Value     Losses     Value     Losses     Value  
    ($ in thousands)  
 
As of June 30, 2011
                                               
Investment securities, available-for-sale:
                                               
Agency callable notes
  $ (569 )   $ 29,415     $     $     $ (569 )   $ 29,415  
Agency MBS
    (696 )     127,134                   (696 )     127,134  
Corporate debt
    (15 )                       (15 )      
Non-agency MBS
    (5 )     1,841       (1,198 )     22,175       (1,203 )     24,016  
U.S. Treasury and agency securities
    (16 )     19,780                   (16 )     19,780  
                                                 
Total investment securities, available-for-sale
  $ (1,301 )   $ 178,170     $ (1,198 )   $ 22,175     $ (2,499 )   $ 200,345  
                                                 
Total investment securities, held-to-maturity(1)
  $ (261 )   $ 43,323     $     $     $ (261 )   $ 43,323  
                                                 
As of December 31, 2010
                                               
Investment securities, available-for-sale:
                                               
Agency callable notes
  $ (1,749 )   $ 92,471     $     $     $ (1,749 )   $ 92,471  
Agency MBS
    (5,321 )     252,844                   (5,321 )     252,844  
Non-agency MBS
    (835 )     20,905       (38 )     8,384       (873 )     29,289  
U.S. Treasury and agency securities
    (478 )     20,151                   (478 )     20,151  
                                                 
Total investment securities, available-for-sale
  $ (8,383 )   $ 386,371     $ (38 )   $ 8,384     $ (8,421 )   $ 394,755  
                                                 
Total investment securities, held-to-maturity(1)
  $ (97 )   $ 13,524     $     $     $ (97 )   $ 13,524  
                                                 
 
 
(1) Consists of commercial mortgage-backed securities rated AAA held by CapitalSource Bank.
 
Securities in unrealized loss positions are analyzed individually as part of our ongoing assessment of OTTI, and we do not believe that any unrealized losses in our portfolio as of June 30, 2011 and December 31, 2010 represent an OTTI. The losses are primarily related to two Agency callable notes, two Agency MBS, and three non-Agency MBS. The unrealized losses are attributable to fluctuations in their market prices due to current market conditions and interest rate levels. Agency securities have the highest debt rating and are backed by government-sponsored entities. The non-Agency MBS securities also have strong debt ratings and debt metrics. As such, we expect to recover the entire amortized cost basis of the impaired securities. We have the ability and the intention to hold these securities until their fair values recover to cost or maturity.


21


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
As of June 30, 2011, the contractual maturities of our available-for-sale and held-to-maturity investment securities were as follows:
 
                                 
    Investment Securities,
    Investment Securities,
 
    Available-for-Sale     Held-to-Maturity  
          Estimated
          Estimated
 
    Amortized Cost     Fair Value     Amortized Cost     Fair Value  
    ($ in thousands)  
 
Due in one year or less
  $ 25,024     $ 25,177     $     $  
Due after one year through five years
    149,846       151,150       26,348       30,535  
Due after five years through ten years(1)
    86,010       89,458              
Due after ten years(2)(3)
    1,176,469       1,206,958       109,902       111,767  
                                 
Total
  $ 1,437,349     $ 1,472,743     $ 136,250     $ 142,302  
                                 
 
 
(1) Includes Agency and Non-agency MBS, with fair values of $31.5 million and $38.1 million, respectively, and weighted-average expected maturities of 2.62 years and 1.31 years, respectively, based on interest rates and expected prepayment speeds as of June 30, 2011.
 
(2) Includes Agency and Non-agency MBS, including CMBS, with fair values of $1.1 billion and $161.3 million, respectively, and weighted-average expected maturities of 3.70 years and 2.66 years, respectively, based on interest rates and expected prepayment speeds as of June 30, 2011.
 
(3) Includes securities with no stated maturity.
 
 
As of June 30, 2011 and December 31, 2010, our other investments were as follows:
 
                 
    June 30,
    December 31,
 
    2011     2010  
    ($ in thousands)  
 
Investments carried at cost
  $ 32,826     $ 33,062  
Investments carried at fair value
    210       222  
Investments accounted for under the equity method
    28,629       38,605  
                 
Total
  $ 61,665     $ 71,889  
                 
 
Proceeds and net pre-tax gains from the sales of other investments during the three and six months ended June 30, 2011 and 2010 were as follows:
 
                                 
    Three Months Ended June 30,   Six Months Ended June 30,
    2011   2010   2011   2010
    ($ in thousands)
 
Proceeds from sales
  $ 9,923     $ 16,048     $ 20,020     $ 25,472  
Net pre-tax gains from sales
    7,416       7,043       17,251       13,453  
 
During the three and six months ended June 30, 2011, we recorded OTTI of $0.2 million and $0.4 million, respectively, relating to our investments carried at cost. During the three and six months ended June 30, 2010, we recorded OTTI of $0.2 million and $2.2 million, respectively, relating to our investments carried at cost.


22


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Note 7.   Guarantor Information
 
The following represents the supplemental consolidating condensed financial information as of June 30, 2011 and December 31, 2010 and for the three and six months ended June 30, 2011 and 2010 of (i) CapitalSource Inc., which is the issuer of our 2014 Senior Secured Notes, as well as our Senior Debentures and Subordinated Debentures (together, the “Debentures”), (ii) CapitalSource Finance LLC (“CapitalSource Finance”), which is a guarantor of our 2014 Senior Secured Notes and the Debentures, and (iii) our subsidiaries that are not guarantors of the 2014 Senior Secured Notes or the Debentures. CapitalSource Finance, a wholly owned indirect subsidiary of CapitalSource Inc., has guaranteed our 2014 Senior Secured Notes and the Senior Debentures, fully and unconditionally, on a senior basis and has guaranteed the Subordinated Debentures, fully and unconditionally, on a senior subordinate basis. Separate consolidated financial statements of the guarantor are not presented, as we have determined that they would not be material to investors.
 
For additional information related to our 2014 Senior Secured Notes and Debentures, see Note 10, Borrowings.


23


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Balance Sheet
June 30, 2011
(Unaudited)
 
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
    CapitalSource
    Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    ($ in thousands)  
 
Assets
                                               
Cash and cash equivalents
  $     $ 380,278     $ 1,200,131     $ 857     $     $ 1,581,266  
Restricted cash
          36,428       64,686       142             101,256  
Investment securities:
                                               
Available-for-sale, at fair value
          1,448,542             24,201             1,472,743  
Held-to-maturity, at amortized cost
          136,250                         136,250  
                                                 
Total investment securities
          1,584,792             24,201             1,608,993  
Loans:
                                               
Loans held for sale
          112,153       6,857       237             119,247  
Loans held for investment
          4,901,771       217,396       363,569             5,482,736  
Less deferred loan fees
                                               
and discounts
          (61,293 )     (5,690 )     (13,298 )     2,690       (77,591 )
Less allowance for loan losses
          (158,432 )     (7,947 )     (32,759 )           (199,138 )
                                                 
Loans held for investment, net
          4,682,046       203,759       317,512       2,690       5,206,007  
                                                 
Total loans
          4,794,199       210,616       317,749       2,690       5,325,254  
Interest receivable
          29,035       23,862       (14,780 )           38,117  
Investment in subsidiaries
    2,515,652       3,156       1,507,197       1,725,726       (5,751,731 )      
Intercompany receivable
    375,000             66,103       920,379       (1,361,482 )      
Other investments
          37,115       13,933       10,617             61,665  
Goodwill
          173,135                         173,135  
Other assets
    70,053       204,355       113,982       183,107       (146,239 )     425,258  
                                                 
Total assets
  $ 2,960,705     $ 7,242,493     $ 3,200,510     $ 3,167,998     $ (7,256,762 )   $ 9,314,944  
                                                 
Liabilities and shareholders’ equity
                                               
Liabilities:
                                               
Deposits
  $     $ 4,785,790     $     $     $     $ 4,785,790  
Term debt
    287,300       410,610                         697,910  
Other borrowings
    528,909       480,000       443,074                   1,451,983  
Other liabilities
    34,081       115,477       116,527       177,055       (174,229 )     268,911  
Intercompany payable
                920,379       415,521       (1,335,900 )      
                                                 
Total liabilities
    850,290       5,791,877       1,479,980       592,576       (1,510,129 )     7,204,594  
Shareholders’ equity:
                                               
Common stock
    3,232       921,000                   (921,000 )     3,232  
Additional paid-in capital
    3,917,768       (64,036 )     706,074       2,595,280       (3,237,355 )     3,917,731  
(Accumulated deficit) retained earnings
    (1,857,283 )     567,504       984,104       (54,748 )     (1,496,888 )     (1,857,311 )
Accumulated other comprehensive income, net
    46,698       26,148       30,352       34,890       (91,390 )     46,698  
                                                 
Total shareholders’ equity
    2,110,415       1,450,616       1,720,530       2,575,422       (5,746,633 )     2,110,350  
                                                 
Total liabilities and shareholders’ equity
  $ 2,960,705     $ 7,242,493     $ 3,200,510     $ 3,167,998     $ (7,256,762 )   $ 9,314,944  
                                                 


24


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Balance Sheet
December 31, 2010
 
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
    CapitalSource
    Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    ($ in thousands)  
 
Assets
                                               
Cash and cash equivalents
  $ 94,614     $ 353,666     $ 252,012     $ 120,158     $     $ 820,450  
Restricted cash
          39,335       85,142       4,109             128,586  
Investment securities:
                                               
Available-for-sale, at fair value
          1,510,384             12,527             1,522,911  
Held-to-maturity, at amortized cost
          184,473                         184,473  
                                                 
Total investment securities
          1,694,857             12,527             1,707,384  
Loans:
                                               
Loans held for sale
          171,887       16,202       17,245             205,334  
Loans held for investment
          5,008,287       284,445       860,144             6,152,876  
Less deferred loan fees
                                               
and discounts
          (79,877 )     (10,362 )     (18,429 )     2,230       (106,438 )
Less allowance for loan losses
          (223,553 )     (29,626 )     (75,943 )           (329,122 )
                                                 
Loans held for investment, net
          4,704,857       244,457       765,772       2,230       5,717,316  
                                                 
Total loans
          4,876,744       260,659       783,017       2,230       5,922,650  
Interest receivable
          25,780       18,174       13,439             57,393  
Investment in subsidiaries
    2,339,200       3,594       1,561,468       1,623,244       (5,527,506 )      
Intercompany receivable
    375,000       9       134,079       301,241       (810,329 )      
Other investments
          52,066       13,887       5,936             71,889  
Goodwill
          173,135                         173,135  
Other assets
    89,198       249,119       156,557       234,034       (164,988 )     563,920  
                                                 
Total assets
  $ 2,898,012     $ 7,468,305     $ 2,481,978     $ 3,097,705     $ (6,500,593 )   $ 9,445,407  
                                                 
Liabilities and shareholders’ equity
                                               
Liabilities:
                                               
Deposits
  $     $ 4,621,273     $     $     $     $ 4,621,273  
Credit facilities
          65,606             1,902             67,508  
Term debt
    285,731       693,523                         979,254  
Other borrowings
    523,650       412,000       440,234                   1,375,884  
Other liabilities
    34,658       170,408       121,227       208,816       (187,563 )     347,546  
Intercompany payable
          46,850       301,241       441,372       (789,463 )      
                                                 
Total liabilities
    844,039       6,009,660       862,702       652,090       (977,026 )     7,391,465  
Shareholders’ equity:
                                               
Common stock
    3,232       921,000                   (921,000 )     3,232  
Additional paid-in capital
    3,911,344       74,588       679,241       2,556,428       (3,310,260 )     3,911,341  
(Accumulated deficit) retained earnings
    (1,870,544 )     457,302       930,076       (114,898 )     (1,272,508 )     (1,870,572 )
Accumulated other comprehensive income, net
    9,941       5,755       9,959       4,087       (19,801 )     9,941  
                                                 
Total CapitalSource Inc. shareholders’ equity
    2,053,973       1,458,645       1,619,276       2,445,617       (5,523,569 )     2,053,942  
Noncontrolling interests
                      (2 )     2        
                                                 
Total shareholders’ equity
    2,053,973       1,458,645       1,619,276       2,445,615       (5,523,567 )     2,053,942  
                                                 
Total liabilities and shareholders’ equity
  $ 2,898,012     $ 7,468,305     $ 2,481,978     $ 3,097,705     $ (6,500,593 )   $ 9,445,407  
                                                 


25


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Statement of Operations
Three Months Ended June 30, 2011
(Unaudited)
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
    CapitalSource
    Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    ($ in thousands)  
 
Net interest income:
                                               
Interest income:
                                               
Loans
  $ 10,183     $ 98,409     $ 11,837     $ 10,048     $ (16,830 )   $ 113,647  
Investment securities
          11,599             1,089             12,688  
Other
          404       686                   1,090  
                                                 
Total interest income
    10,183       110,412       12,523       11,137       (16,830 )     127,425  
Interest expense:
                                               
Deposits
          13,398                         13,398  
Borrowings
    23,851       5,054       4,031       12,537       (13,064 )     32,409  
                                                 
Total interest expense
    23,851       18,452       4,031       12,537       (13,064 )     45,807  
                                                 
Net interest (loss) income
    (13,668 )     91,960       8,492       (1,400 )     (3,766 )     81,618  
Provision for loan losses
          6,340       (3,258 )     (1,559 )           1,523  
                                                 
Net interest (loss) income after provision for loan losses
    (13,668 )     85,620       11,750       159       (3,766 )     80,095  
Operating expenses:
                                               
Compensation and benefits
    667       13,116       15,902             (587 )     29,098  
Professional fees
    4,605       1,437       5,093       (221 )           10,914  
Other administrative expenses
    1,017       20,445       9,468       5,271       (20,891 )     15,310  
                                                 
Total operating expenses
    6,289       34,998       30,463       5,050       (21,478 )     55,322  
Other income:
                                               
Gain on investments, net
          8,413       8       304             8,725  
(Loss) gain on derivatives
          (358 )     5,559       (5,472 )           (271 )
Net (expense) income of real estate owned and other foreclosed assets
          (10,589 )     (47 )     281             (10,355 )
Other (expense) income, net
    (17 )     6,911       22,243       3,569       (21,735 )     10,971  
Earnings (loss) in subsidiaries
    32,703       (78 )     37,015       42,041       (111,681 )      
                                                 
Total other income
    32,686       4,299       64,778       40,723       (133,416 )     9,070  
                                                 
Net income before income taxes
    12,729       54,921       46,065       35,832       (115,704 )     33,843  
Income tax (benefit) expense
    (3,865 )     17,764             3,350             17,249  
                                                 
Net income
  $ 16,594     $ 37,157     $ 46,065     $ 32,482     $ (115,704 )   $ 16,594  
                                                 


26


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Statement of Operations
Three Months Ended June 30, 2010
(Unaudited)
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
    CapitalSource
    Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    ($ in thousands)  
 
Net interest income:
                                               
Interest income:
                                               
Loans
  $ 10,191     $ 101,450     $ 13,925     $ 37,434     $ (14,203 )   $ 148,797  
Investment securities
          15,334       30       255             15,619  
Other
          300       2       2             304  
                                                 
Total interest income
    10,191       117,084       13,957       37,691       (14,203 )     164,720  
Interest expense:
                                               
Deposits
          15,279                         15,279  
Borrowings
    24,109       8,430       7,764       18,214       (13,039 )     45,478  
                                                 
Total interest expense
    24,109       23,709       7,764       18,214       (13,039 )     60,757  
                                                 
Net interest (loss) income
    (13,918 )     93,375       6,193       19,477       (1,164 )     103,963  
Provision for loan losses
          12,310       (24,316 )     37,268             25,262  
                                                 
Net interest (loss) income after provision for loan losses
    (13,918 )     81,065       30,509       (17,791 )     (1,164 )     78,701  
Operating expenses:
                                               
Compensation and benefits
    638       12,572       16,213                   29,423  
Professional fees
    480       643       6,537       837             8,497  
Other administrative expenses
    1,230       18,173       11,424       (1,419 )     (13,737 )     15,671  
                                                 
Total operating expenses
    2,348       31,388       34,174       (582 )     (13,737 )     53,591  
Other income:
                                               
Gain on investments, net
          8,727       251       1,279             10,257  
Gain (loss) on derivatives
          837       10,906       (15,357 )           (3,614 )
Net expense of real estate owned and other foreclosed assets
          (4,745 )     (178 )     (38,252 )           (43,175 )
Other (expense) income, net
    (327 )     17,668       4,650       (6,394 )     (13,871 )     1,726  
Earnings (loss) in subsidiaries
    34,157       (3,105 )     60,411       71,077       (162,540 )      
                                                 
Total other income
    33,830       19,382       76,040       12,353       (176,411 )     (34,806 )
                                                 
Net income (loss) from continuing
                                               
operations before income taxes
    17,564       69,059       72,375       (4,856 )     (163,838 )     (9,696 )
Income tax benefit
    (776 )     (2,046 )           (1,352 )           (4,174 )
                                                 
Net income (loss) from continuing operations
    18,340       71,105       72,375       (3,504 )     (163,838 )     (5,522 )
Net income from discontinued operations, net of taxes
                      2,166             2,166  
Net gain from sale of discontinued operations, net of taxes
                      21,696             21,696  
                                                 
Net income
  $ 18,340     $ 71,105     $ 72,375     $ 20,358     $ (163,838 )   $ 18,340  
                                                 


27


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Statement of Operations
Six Months Ended June 30, 2011
(Unaudited)
 
                                                 
          CapitalSource Finance LLC                    
          Combined
    Combined
    Other
          Consolidated
 
    CapitalSource
    Non-Guarantor
    Guarantor
    Non-Guarantor
          CapitalSource
 
    Inc.     Subsidiaries     Subsidiaries     Subsidiaries     Eliminations     Inc.  
    ($ in thousands)  
 
Net interest income:
                                               
Interest income:
                                               
Loans
  $ 20,377     $ 203,463     $ 9,946     $ 30,586     $ (27,225 )   $ 237,147  
Investment securities
          26,322       7       4,711             31,040  
Other
          642       741       7             1,390  
                                                 
Total interest income
    20,377       230,427       10,694       35,304       (27,225 )     269,577  
Interest expense:
                                               
Deposits
          26,781                         26,781  
Borrowings
    48,276       10,764       8,948       23,790       (26,000 )     65,778  
                                                 
Total interest expense
    48,276       37,545       8,948       23,790       (26,000 )     92,559  
                                                 
Net interest (loss) income
    (27,899 )     192,882       1,746       11,514       (1,225 )     177,018  
Provision for loan losses
          5,543       36,945       3,844             46,332  
                                                 
Net interest (loss) income after provision for loan losses
    (27,899 )     187,339       (35,199 )     7,670       (1,225 )     130,686  
Operating expenses:
                                               
Compensation and benefits
    902       25,144       34,849             (1,418 )     59,477  
Professional fees
    5,569       1,896       9,927       710             18,102  
Other administrative expenses
    2,173       42,264       20,507       9,650       (42,590 )     32,004  
                                                 
Total operating expenses
    8,644       69,304       65,283       10,360       (44,008 )     109,583  
Other income:
                                               
Gain on investments, net
          20,062       30       12,148             32,240  
(Loss) gain on derivatives
          (1,135 )     4,437       (5,451 )           (2,149 )
Net expense of real estate owned and other foreclosed assets
          (12,932 )     (236 )     (7,360 )           (20,528 )
Other (expense) income, net
    (334 )     11,890       40,969       6,592       (41,619 )     17,498  
Earnings (loss) in subsidiaries
    59,948       (1,176 )     109,300       55,191       (223,263 )      
                                                 
Total other income
    59,614       16,709       154,500       61,120       (264,882 )     27,061  
                                                 
Net income before income taxes
    23,071       134,744       54,018       58,430       (222,099 )     48,164  
Income tax expense (benefit)
    3,318       24,544       (10 )     559             28,411  
                                                 
Net income
  $ 19,753     $ 110,200     $ 54,028     $ 57,871     $ (222,099 )   $ 19,753  
                                                 


28


Table of Contents

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Consolidating Statement of Operations
Six Months Ended June 30, 2010
(Unaudited)